Why bitcoin's success could be its downfall

U.S. exchange groups and markets, including NASDAQ and CME Group Inc., will begin trading Bitcoin in 2018. The value of the cryptocurrency has soared to $17,000 a coin in December. (Jhaan Elker/The Washington Post)

Digital currencies have been front-page news as the value of bitcoin, the most popular of the cryptocurrencies, continues to surge, albeit with wild fluctuations. Bitcoin backers argue that once digital currencies become widely used, governments will be unable to destroy them — users simply won’t allow it.

This view falls short on two points. First, digital currencies, even in their current form, are a bigger threat to national governments than most people currently understand.

Second, bitcoin’s success would also be its downfall. As bitcoin gains popularity, and especially if it stabilizes in value, it becomes a viable substitute for government-backed currencies. But national governments have little incentive to allow this type of direct competition.

The hidden cost of digital currency

National governments tolerate bitcoin and other forms of cryptocurrency because these currencies are still bit players in the global economy. Bangladesh, Bolivia and Kyrgyzstan are among the handful of countries to have banned bitcoin transactions. The United States, Japan, the European Union and other governments have discussed stricter controls, but most seem to be taking a wait-and-see approach to regulation.

For now, currencies like bitcoin are too volatile to be used for long-term saving or lending — this means they won’t readily replace dollars or euros. But governments cannot control the movement of digital currencies across borders — and that’s why these currencies already pose a threat. Digital currencies can provide a means to evade government restrictions on currency exchange and capital outflows.

Our research shows that countries frequently impose currency restrictions for political and economic benefit. By restricting the conversion of their national currency into dollars, for instance, national governments can prevent investors from fleeing their economy too quickly.

Or governments can move to stabilize the national currency in times of crisis. The United Kingdom may well tinker with its currency exchanges to “manage” Brexit better domestically, for example. If citizens hold large bitcoin reserves, their holdings are effectively free from these types of traditional government restrictions on currency flows.

Bitcoin backers may believe governments couldn’t kill off bitcoin or other digital currencies — but this is a mistaken assumption. Governments can make the possession, use and exchange of bitcoin illegal. While a democratic government might be hesitant to ban bitcoin if citizens strongly oppose doing so, such a ban is clearly within its power. Governments regulate, and even ban, currencies all the time.

In recent years, China’s foreign-exchange regulator has instructed banks to increasingly cap how much money companies and individuals can move out of the country. India demonetized in late 2016, requiring all citizens to exchange their high-denomination bills, causing shortages, delays and blocked exchange.

The U.S. government has also stepped in to limit the use of monetary instruments in the past. During the Great Depression, the government made it a crime to possess gold coins or gold bars, forcing citizens to sell their gold to the Treasury.

While there are no exact historical parallels to bitcoin, few economists doubt that the U.S. government can force Americans to abandon bitcoin if it wants. As Nobel laureate Joseph Stiglitz put it recently, “They can crack down at any time, and then [bitcoin] collapses.”

A visual representation of the digital cryptocurrency bitcoin. Cryptocurrencies including bitcoin, ethereum and litecoin have seen unprecedented growth in 2017 — and extreme bouts of volatility. (Getty Images)

So why would expanded use of bitcoin mean its political demise?

Bitcoin’s volatility continues to prevent its widespread, everyday use. But what if bitcoin or another digital currency solves the volatility problem? This would mean citizens might prefer to borrow, invest and trade in a currency whose movement and valuation is outside of government control. That would threaten national governments, including the U.S. government.

Don’t forget that the United States profits from issuing U.S. dollars that are then held for decades by individuals and governments overseas — these are essentially interest-free loans to the U.S. economy. These benefits are worth roughly $20 billion per year.

More important, the U.S. government needs to control the value of the dollar for two critical reasons: to manage the competitiveness of its exports and to ensure that it can always roll over the enormous U.S. national debt. Thus, the United States has good reason to fight tooth and nail to kill any digital currency that competes with the dollar.

Governments have little reason to allow bitcoin to take away their ability to move home currency markets to their advantage. This goes for the United States, the European Union and emerging markets as well.

While bitcoin is real and very alive today, there is reason to believe its success would be its own demise. Our analysis suggests that either bitcoin remains volatile and investors eventually walk away — or bitcoin stabilizes and becomes widely popular, only to die a slow, painful death by a thousand regulatory cuts across a hundred political jurisdictions.